Reading the fine print: Demystifying contractual language in construction credit

Contract review is a core responsibility for credit professionals, requiring careful attention to detail and consistency across agreements. However, when managing high volumes under tight timelines, even well-established processes can leave room for key terms to be overlooked.

Why it matters: Thoroughly reviewing contractual agreements is vital for asserting individual rights and protections. In construction credit, a full understanding of what you’re signing can be the difference between securing rights and losing them entirely.

Contracts are intended to secure rights and protections for those involved. But when they are frequently filled with vague or ambiguous legal terms, these rights and protections can be overlooked and compromised. For construction creditors, this can lead to delayed collections or exposure to greater financial risk for their company.

“Contractual language can be interpreted differently based on the situation,” said Isaac Kotila, regional credit manager at Insulation Distributors Inc. (Chanhassen, MN), during an NACM webinar, Reading Construction Contracts Like a Credit Manager: Pay-if-Paid, Retainage and Risk Traps. “For instance, the word ‘promptly’ to a smaller organization could mean the same day or next day but for a larger organization, it could mean weeks or a month.”

Pay-If-Paid vs. Pay-When-Paid

The contractual language surrounding pay-if-paid and pay-when-paid provisions is among the most confusing for credit professionals. Because these clauses are often hidden behind legal jargon, they are easy to misinterpret or overlook. “Pay-if-paid and pay-when-paid clauses read similarly in contracts,” said Michael Murray, attorney at Lanak & Hanna, P.C. (Orange, CA). “Unless you are paying close attention, you can misunderstand the clause.”

What makes them more difficult to understand is ambiguous language. “Pay-when-paid clauses will read along the lines of, ‘the GC will issue payment once received from the owner within a reasonable amount of time,’” said Kotila. “If you don’t specify what a reasonable amount of time means, you can’t determine when that payment will be received.”

Though similar in name, the two clauses carry very different implications, and failing to distinguish between them can significantly impact credit risk on a project.

The pay-when-paid clause, for instance, is a timing mechanism that delays the time in which a general contractor (GC) has to pay a subcontractor without ever extinguishing that responsibility, according to Levelset. Whereas, a pay-if-paid clause makes the owner sign a precedent to the subcontractors getting paid, which means if the GC doesn’t get paid, neither do any of the subcontractors.

Distinguishing between the two is made possible through key wording. Pay-if-paid clauses typically contain conditional language such as ‘if’ or ‘if and only if,’ whereas pay-when-paid clauses will often include the word ‘when.’

Best Practices for Securing Lien Rights

Through careful review and a clear understanding of the contract, credit professionals can ensure their lien rights are protected. “Oftentimes, credit professionals assume that contracts are non-negotiable but in reality, they’re quite amendable,” said Murray. “Some credit professionals don’t realize they can closely review a contract and, if necessary, redline or cross out anything they don’t like, then send it back for revision.”

By doing so, they can ensure they don’t agree to any provisions that could negate their lien rights. “Say you signed a pay-when-paid clause and a bond claim deadline is coming up,” said Murray. “Depending on the state, the surety could be completely external, meaning the surety is not bound to that clause. Through careful review of the contract, you may be able to file a claim and get paid out of a payment or performance bond in the event you’re not paid even with those clauses.”

It is also helpful to check whether the clause contains a clear condition precedent—language that explicitly states the contractor is assuming the risk of non-payment in the event of an owner default. “It has to be clearly defined in almost all instances for it to be enforceable,” said Kotila. “If the language is ambiguous or blends elements of both clauses, there may be grounds to argue it functions as a pay-when-paid rather than a pay-if-paid clause.”

Some credit professionals may not know if they’re subject to pay-when-paid or pay-if-paid clauses. Asking for a copy of the general contract can help determine that. For others, NACM Secured Transactions Services’ (STS) Lien Navigator serves as a powerful tool, outlining lien laws by state.

The bottom line: In construction credit, it is not simply a matter of reading the fine print. By taking the time to fully read, question and—when necessary—push back on contract language, credit professionals can protect their lien rights and significantly reduce credit risk.